European politics

The ECB and the euro

Too central a banker?

WHEN European leaders declare that they will do whatever is necessary to protect the euro zone, most people just yawn. But when Mario Draghi, president of the European Central Bank, said the same in July, everybody took notice.

This week plaudits (and some protests) have been showered on Mr Draghi after he confirmed on September 6th (over the explicit objections of Germany's Bundesbank) that the ECB would resume buying the bonds of troubled countries—on strict condition that stricken countries submit to formal, externally monitored reform programmes. (The details are here, the transcript of the press conference is here and the assessment of my fellow Economist blogger is here).

Often in the crisis the ECB has appeared to be the only thing standing between the euro and the abyss. This has brought it ever greater influence. The proposed new banking supervisor for the euro zone will be an offshoot of the ECB (see my column this week, Eurobankingfragilistic). Moreover, the ECB's officials are part of the troika that monitors and enforces countries' compliance with their bail-out conditions. And when it comes to the future of the euro zone, Mr Draghi has become the most explicit of the “four presidents” (of the ECB, the European Council, the European Commission and the Eurogroup of finance ministers) who are drafting a “road map” for future integration (their first report is here)

All this raises a question: is the ECB becoming too powerful? Is it straying too far from a central banks’ role of setting interest rates and controlling inflation? Is it becoming too overtly political?

Figures close to the ECB argue that, at a time when Europe is confronting its greatest economic crisis since the second world war, European institutions must respond with the imperfect means at their disposal. The European Union, or even the euro zone, is not a federal state. So it is up to the most integrated parts of it to show leadership.

That the ECB should take such a central role is in many ways a reflection of the failure of the euro-zone’s political leaders to bring the debt crisis under control in more than two years of emergency summits and bail-outs. There reasons are many: publics are reluctant to give up sovereignty and share risks to the degree needed to stabilise the currency; parliaments are reluctant to give out taxpayers' money; debtor states are resistant to demands for ever more austerity. None of Europe’s leaders except Germany's chancellor, Angela Merkel—and probably not even her—can resolve the crisis alone. Yet every leader can place obstacles in the way of solutions. So progress, when it takes place, is measured in haphazard half-steps, which never quite satisfies investors who want certainty.

Mr Draghi is in an entirely different position. Whereas politicians must raise money from taxpayers, the ECB can in theory print unlimited quantities of the stuff. As an independent central banker he is accountable to no government or parliament—only to other unelected central bankers in the ECB's governing council. The only real obstacle is the Bundesbank's chief, Jens Weidmann. But in a body where Germany has the same vote as Greece, Mr Weidmann can easily be outvoted—as he was this week. Despite his denunciation of the bond-buying plan, Mr Weidmann shows no sign of resigning in protest.

Mr Draghi is supposed to rise above base politics, yet he takes part in every European summit. His public pronouncements are studied like Greek oracles. The high priest of Europeanism does not officially negotiate with leaders. But Like Jean-Claude Trichet before him, he sends messages to political leaders from the top of the Eurotower in Frankfurt, listens for a response and then pronounces.

Last December Mr Draghi spoke vaguely of the need for a “fiscal compact” and, lo, leaders agreed to a new treaty enshrining balanced-budget rules. Mr Draghi then sprayed the banks with €1 trillion worth of cheap money.

Now Mr Draghi is setting conditions more explicitly. Forget “light” forms of conditionality. The ECB said it would resume its dormant bond-buying programme only if two conditions were met. First, countries needing help must ask for it and submit to a fully-fledged programme agreed and monitored by European institutions (and preferably by the IMF too). Second, the rescue funds should start buying bonds in the primary market. This could be done by the temporary European Financial Stability Facility, or the new improved European Stability Mechanism that should soon enter into force, pending a ruling by Germany's constitutional court on September 12th.

In the past, the ECB’s conditions would be spelled out in secret letters, for instance when the ECB started buying Italian bonds last year (see my earlier blog post here). Now the ECB wants the conditions to be made explicit by governments. Bond-buying would end when the (unspecified) objective had been achieved, says Mr Draghi, or if the country in question breached the terms of its reform programme.

Mr Draghi, then, is not going to stand in the front line wielding the ECB's big bazooka. But if others man the trenches, he will provide artillery support from the rear to avert a catastrophe. Mr Draghi himself uses a different image: the response to the crisis has to stand on “two legs”. ECB action without reforms would be ineffective. But he also acknowledges that reforms by governments are taking too long to bear fruit and need to be supported by the ECB.

Mr Draghi justifies his action with the argument that high yields faced by southern European governments are not only the product of a higher credit risk, but also the result of markets' “unfounded” fear that the euro would break up. The former is a matter for governments, but the risk of currency redenomination is the ECB's business because it impedes “the transmission of monetary policy”. It is an appealing argument, but hard to put a number on the extra interest countries are paying because of the convertibility risk.

Nevertheless, Mr Draghi insists the euro is irreversible. The ECB's intervention in the market is aimed at removing the “tail risk” of a break-up. At his press conference a journalist cheekily asked why it was Mr Draghi's job to ensure the euro’s irreversibility. By what authority could he decide what currency countries should use? Mr Draghi offered no real answer.

Even if one accepts the premise that saving the euro is part of the ECB's mandate, Mr Draghi is straying into awkward territory. The ECB's independent action has been made dependent on fickle politicians. At least indirectly, Mr Draghi will be bargaining with governments over the terms of their reform programme.

To the irritation of the ECB and Brussels institutions, the Spanish prime minister, Mariano Rajoy, has prevaricated for weeks over whether to seek more assistance, declaring he would wait to see the ECB's terms before deciding whether to ask for help. What if Mr Rajoy takes the money but is later deemed to have missed its targets for reform? If Mr Draghi really cuts off a country like Spain, he would surely be calling into question the future of the euro after all.

There are other worries. Next week the European Commission will propose placing all of the euro zone's 6,000-odd banks under an ECB-directed central supervisor. Many worry that, despite the attempt to place a Chinese wall between the supervisory and monetary roles, the ECB's hallowed independence will become compromised by taking on the huge new task. Can the ECB really separate its decisions on inflation-fighting from its growing role in ensuring financial stability? Perhaps more importantly, would the ECB’s reputation for competence survive a major failure of supervision?

Then there is the question of how to fix the design flaws of the euro zone. An article written by Mr Draghi last month for the German daily, Die Zeit, caused much excitement because the mention of “exceptional measures” seemed to confirm that the bond-buying programme would be restarted.

In fact, most of the piece set out Mr Draghi’s vision for the economic and political integration of the euro zone. It is not just the currency that should be irreversible, he said, but also the whole “historic process of European unification”. In his view, stabilising the euro would require political integration that stops short of a full federation.

...this new architecture does not require a political union first. It is clear that monetary union does entail a higher degree of joint decision-making. But economic integration and political integration can develop in parallel. Where necessary, sovereignty in selected economic policy fields can and should be pooled and democratic legitimation deepened.

How far should this go? We do not need a centralisation of all economic policies. Instead, we can answer this question pragmatically: by calmly asking ourselves which are the minimum requirements to complete economic and monetary union. And in doing so, we will find that all the necessary measures are firmly within our reach.

For fiscal policies, we need true oversight over national budgets. The consequences of misguided fiscal policies in a monetary union are too severe to remain self-policed. For broader economic policies, we need to guarantee competitiveness. Countries must be able to generate sustainable growth and high employment without excessive imbalances. The euro area is not a nation-state where persistent cross-regional subsidies have sufficient popular support. Therefore, we cannot afford a situation where some regions run permanently large deficits vis-à-vis others.

For financial policies, there need to be powers at the centre to limit excessive risk-taking by banks and regulatory capture by supervisors. This is the best way to protect euro area taxpayers. There also needs to be a framework for bank resolution that safeguards public finances, as we see in other federations. In the U.S., for example, on average about 90, mostly smaller, banks per year have been resolved since 2008 and this had no impact on the solvency of the sovereign.

Political union can, and shall, develop hand-in-hand with fiscal, economic and financial union. The sharing of powers and of accountability can move in parallel. We should not forget that 60 years of European integration have already created a significant degree of political union. Decisions are made by an EU Council filled by national ministers and by a directly elected European Parliament. The challenge is to further increase the legitimacy of these bodies commensurate with increasing their responsibilities and to seek ways to better anchor European processes at the national level...

It is hard to imagine any other central banker setting out such a detailed political blueprint for economic and constitutional reform. Then again, the ECB is no ordinary central bank and these are no ordinary times. In a crisis it may make sense for a trusted figure to offer direction, even to take risks. But it is not a role that an unelected central banker can play for too long.

"At his press conference a journalist cheekily asked why it was Mr Draghi's job to ensure the euro’s irreversibility. By what authority could he decide what currency countries should use? Mr Draghi offered no real answer."

Well, hard to see a purpose for the ECB without the Euro. And moreover, it´s mandate of stable prices rather becomes pointless, if the Euro itself doesn't survive.
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"The euro area is not a nation-state where persistent cross-regional subsidies have sufficient popular support. Therefore, we cannot afford a situation where some regions run permanently large deficits vis-à-vis others."

That is clarity of thinking.

Many have pointed this out, but now finally Europe has a top central banker, that dares telling the bleating obvious.

Unfortunately if all of his suggestions become operational without a political union, the so call democratic deficit would become a yeawning chasm.

So Europe only needs to develope a political union at the same time, but it's hard to see that the EZ populations, would stand for being ruled from above from unelected officials.

Is really within ECB's mandate to order Bank of Finland to buy Greek bonds from German and French private banks? When Greece exits euro and defaults, the bill is then on Finnish tax payers, instead of those bankers that were responsible and made hefty profits out of their ponzi scheme? (Mr. Liikanen from Finland - an ex member of EU commission - has stated the he'll never oppose any decision within ECB, only try influencing in context.)

This is an outrage.

The whole farce with EZ has had one simple plot: How to remove responsibilities from those who should be responsible, to the ones that have been responsible managing their own economies in tact. Finland has absolutely nothing to do with irresponsibility of far away countries of Greece, Portugal, Ireland, Spain and Italy.

It's a sickening reality now, that Finland is on the hook, not only paying bills of PIIGS, but now also taking future losses of German and French (and Spanish and...you name it...Finnish bank have not been financing of hopeless countries).

The whole thing is perverse. In normal market economy it pays to manage things well, it pays to succeed, it pays to work hard. Now this is turned upside down.

This is an unlawful robbery. To whom do I turn?!

Ultimately these bailouts will lead to destruction of the whole world's economies.

To put Soros's message in simple English - Germany should transfer its wealth to nations which spend more than they earn otherwise it is a selfish nation. Laziness and profligacy has consequences. Wealth transfer is not the medicine to cure Greek lifestyle.I thank you Firozali A.Mulla DBA

What kind of claptrap is this? Anything the European do is wrong. Central bank does nothing. That's wrong. Central bank does something (the same thing you guys have been screaming for from a year back) they are becoming too powerful. Politicians have failed. Can you guys not write straight? Is this crooked cynicism part of the psyche of this magazine?

It's becoming clear that the Euro is not going to be allowed to break up. The reason is that the short term costs of breakup are known to be very high even though the long term costs of shackling low productivity economies to high productivity ones may be much higher. Of course the Euro is not irreversible, but it seems to be too painful to break up and politically impossible to fix. The ECB can always forestall a catastrophic break-up. Therefore it seems that the crisis will roll on indefinitely consigning peripheral economies to prolonged depression whilst dragging the growth of the export driven core and possibly overheating them. The Euro was intended to synchronise the economies of the common currency zone but clearly this is not happening. Productivity improvements will take years, perhaps a decade or more and places like Greece will never be as productive as Germany, for reasons of location alone.

There are advantages to a hard common currency. Consumers and savers obviously prefer it but it doesn't matter what currency have if you don't have a job or savings. Eventually this point will get through.

@ Mario: “we have just seen that OMTs will not be actually open-ended at all — quite apart from their conditionality — because of the sheer sterilisation requirement. Those who hope (or fear) a cheap financing bonanza for profligate governments bent on empty promises of future virtue seem thus badly off the mark.”

Yes this is a profoundly significant development – not because it will cap the interventions as you (and the poor confused Bundesbank) believe but because it is the direct route to eurozone debt mutualisation.

The ECB will effectively be selling eurozone paper (in the form of ECB bills) to sterilise it’s “unmlimited” purchases of Spanish and Italian debt. The market will be buying joint eurozone liabilities in exchange for Italian and Spanish paper. Market demand for this sort of collateral is effectively unlimited right now (so there goes your cap).

No treaty required, no messy Parliamentary votes necessary, no bossy national court interference – just the cumulative transfer of peripheral debt to joint eurozone obligations via the ECB.

That Draghi made this look like a late concession to Bundesbank pressure is a particularly exquisite display of negotiating skill given the central role that this sterilisation requirement will play in realising his objective of converting the eurozone to a fully fledged debt union.

Draghi’s achievement this week is threefold:

1. He has removed Germany as the arbiter of eurozone policy.
2. He has laid the foundations for a eurozone debt union.
3. In the short term he has reduced Italian and Spanish cost of debt so much that providing they issue their paper quickly enough they can cheaply roll over a lot of debt without conceding any new austerity at all. This cushion will strengthen their negotiating hand against the crazed counter cyclical austerity demands to which Draghi only pays lip service to. Free of the fear of Germany you can expect a much more confrontational and anti austerity rhetoric to come from these players in future.

Even as a lifelong Eurosceptic I can hardly forbear to cheer at the bravura display of tactical and strategical skill involved….

Once unelected eurocrats can grab too much power, the democracy is in a free fall and can turn the continent into an ideal breeding ground for extreme ideologies, where breiviks or opposite extremists are anomalies no more. Replacing elected ones by "professional functionaries" bears a lenient name of corporatism, but is per se a form of dictatorship.

Isn´t it funny that most of the calls for the ECB to do something came from the nations that historically treated their central banks like printing machines subordinates ? ( Spain , Italy , Greece) Why was it that Pesetas, Liras etc. , were printed with many zeros on the bank bills while northern Europeans bills did not ? Ooooooh Wait that was to create the illusion of being rich while not doing much to improve products and productivity.

Dragi is the most dangerous man on the planet. An unelected technocrat with no democratic legitimation, an Goldman-Sachs acolyte on top of that, a defender of the interests of the ClubMed countries, may it cost the Germans what it wants, he installs a feudal system, uncontrollable, unstoppable.

Most revealing his "...we need true oversight over national budgets...". The national budgets are and must stay in the sole responsibility of the nations.

@Black Hawk: "You seem a bit confused on the meaning of sterilisation."

Black Hawk down methinks.

Sterilisation is merely a monetary offset. For every euro in Spanish debt purchased a euro in ECB backed debt is sold. This means there is no monetary effect (i.e. no net increase in the money supply) arising from the Spanish bond purchases.

You seem to think that sterilisation means that the ECB cannot expand it's own balance sheet. A casual acquaintanceship with it's actions over the past two years should long since have disabused you of this naive delusion.

With sterilisation an expanded ECB balance sheet is monetarily neutral. But it does have the profoundest implications for the capitalisation risk carried by it's national backers.

Hold on. Perhaps it's just me, but I feel that most people here — from Charlemagne down — are leaving out a small technical detail that is in fact rather basic to understand the full implications Mr Draghi's move. Besides "conditionality" and "coverage" — mentioned by everybody — there is a third restriction on the new Outright Monetary Transactions (OMTs) by the ECB: the stern stipulation that all liquidity created through OMTs will be fully sterilised.

That appears to have two immediate and momentous implications. First, OMTs will have no effect at all on the EZ's money supply. Second, the need to sterilise them will by itself put a close upper limit to the amount of feasible OMTs during any given period. This is so because any acquisition of OMTs assets by the ECB will have to be instantly compensated by an equivalent shedding of other assets — such us commercial banks refinancing — and there are obvious limitations to the extent to which this can be done in practice.

So, the ECB is in fact keeping intact its complete independence in the determination of the money supply (M): "open-ended" OMTs will only happen within a predetermined M-growth objective, with the aim to influence the level and structure of interest rates, to make them consistent with that objective and the target inflation rate. Moreover, we have just seen that OMTs will not be actually open-ended at all — quite apart from their conditionality — because of the sheer sterilisation requirement. Those who hope (or fear) a cheap financing bonanza for profligate governments bent on empty promises of future virtue seem thus badly off the mark. If the ECB sticks to its own new rules (and there is as yet no reason to doubt that) no such folly can be in sight — indeed, no "Italian solution", like financing a third or more of the State's yearly expenditure by newly produced monetary base, as it happened in Italy during the early 1970's. Sterilised OMTs will only shield Treasuries from short-run bubbles in debt-markets interest rates, unsupported by fiscal fundamentals, but cannot realistically fuel long-run fiscal irresponsibility.

Yet, if all this is true, the strictly political implications of Mr Draghi's move appear to be much smaller than many seem at present to think.

"For financial policies, there need to be powers at the centre to limit excessive risk-taking by banks and regulatory capture by supervisors."

"The euro area is not a nation-state where persistent cross-regional subsidies have sufficient popular support."

Both the statements focus at centralizing the Eurozone within the hands of Germany, UK and France and subjugating other Euro nations. Eurozone was destined to fail from the start, and now it is being monopolized by the three states. Looks like the blood of colonialism era is still running deep!

Draghi's move is just another morphine shot to a terminally ill euro. His own personal interest, like all Euro politicians, is to keep the golden job + perks. Thus the lies they want us to believe.
The euro was a bad project, doomed from day one, the largest financial fiasco in history. Despite artificial over-evaluation for many years, the farce couldn't hold forever.

The foundation of the Markets in Finacial Instruments Directive 2004 (MiFID), states an investment firm can set up a branch in a 'home country' and partake in trading on the single european market, including in other European national markets free from any restrictions as once it meets all legal obligations with repect that that countries regulations.

Therefore with the introduction of this we have seen a number of 'subsidary bank' ie Ulster Bank is to RBS for one example.

If a 'home state' investment firm (RBS) based on market inside knowledge invests large quantites of resources in 'subsidary bank' (Ulster Bank) in hope of manipulating growth in the economy is this not the same as 'Ficticious Devices' as outlined under the Central Bank and Finacial Services Authority Act.

Given this then lead to the strenghting of the Euro would this under the same act of legislation be regarded as 'price positioning'?

Under the above legisaltion it is the entitlment of the Financial Regulator of sovern states to request all documentation with regards to any wrong doing precieved. (In this case 'Insider Dealing').

Under the Central Bank and Financial Serivces Act would it not be possible in certain cases to impose a maximium fine of 10 million or maximuim of 10 years sentence on those in European Financial Institutions?.

Those people who may be innocent can be compensated under Investment Compensation Company Limited (ICCL) if they have lost invested pensions for example.

A dream I know.

Would be interested to hear from my friend Zobras, Pumper, A.J.Maher, Birdnick,LyV and Vivahorsemachete

"For financial policies, there need to be powers at the centre to limit excessive risk-taking by banks and regulatory capture by supervisors."

"The euro area is not a nation-state where persistent cross-regional subsidies have sufficient popular support."

Both the statements focus at centralizing the Eurozone within the hands of Germany, UK and France and subjugating other Euro nations. Eurozone was destined to fail from the start, and now it is being monopolized by the three states. Looks like the blood of colonialism era is still running deep!

Thank you for your perceptive review of the changing role of the ECB under Draghi's leadership. It does seem that this is part and parcel of a characteristic feature, inherent in the integration process, within which the failure of democratic/political decision-making is resolved by a progressive accretion of bureaucratic decision-making by non-elected functionaries.

The enhanced political role of the ECB appears as a direct consequence of the failure of economic decision-making by the political institutions of the community. It may also be true that, even in those countries such as the UK and the USA, the apparently intractable economic crisis is leading politicians to cede more economic decision-making to non elected officials in the Central Banks.

On the related issue of European political integration. The excerpts from Draghi's speech suggest to me that the conclusion - 'stabilising the euro would require political integration that stops short of a full federation' - is ingenuous. A careful reading of the listed changes required for effective integration, would allow little scope for national decision-making other than the composition of the national anthem and the language in which it should be sung!